Pakistan’s Digital Lending Revolution

The cruel spiral of poverty plagues generations once it takes grip. It takes money to make money. This is especially true of emerging and undocumented economies like ours. It takes money to educate one’s children, without which income prospects greatly diminish for the next generation. It also takes money for a small business owner to invest in stock or supplies. Without this, no income is generated from the business which feeds a disproportionate number of people downstream. Often, health issues can devastate families and their fortunes because a head of household was not able to afford medical treatment.

Poverty is not new. However, we have, for the first time in history, witnessed such a massive and rapid deliberate reduction in the world’s poverty. China systematically lifted 800 million people out of its poverty spiral over a relatively short 40-year period. There are many lessons in this for Pakistan, the biggest of which is that it is indeed possible to turn the corner for our people.

China relied heavily on digital technologies that financially included a significant portion of its population, and also connected them for commerce with each other. Mobile smartphone penetration, online connectivity, digital payments, and online commerce became key catalysts of income mobility. The ensuing digital footprints paved the way to provide credit to people who were previously undocumented and thus un-lendable. There is no debate now that access to credit is one of the most effective ways to reduce poverty. And today, digital access to credit can reduce poverty at scales and speeds previously unimaginable.

Pakistan has recently undergone its digital revolution. Today 80% of adults in Pakistan have access to internet-connected smartphones. About a third have made digital payments. Seventy percent of new bank accounts over the last five years were contributed by mobile wallets. Our chowkidars, mazdoors and corner store owners are all on WhatsApp and avidly consuming TikToks. E-commerce, although still relatively small with a market size of about six billion dollars annually, has shown one of the fastest growths globally. Key catalysts of income mobility are now present for us to take advantage of.

So why do less than two percent of our population receive loans from formal financial institutions? Because formal financial institutions employ traditional ways of establishing creditworthiness, by collecting documents. The size of our undocumented economy is at least as large as our formal economy and comprises the vast majority of our population. With no signals of creditworthiness, money is not lent. With poor signals of creditworthiness, money is lent but de-risked by pledging tangible assets, which are uncommon among the poor.

The scarcity of credit given by banks to consumers and small businesses is further compounded by the fact that it is hard work to give small loans with cumbersome and expensive physical processes. There is little incentive to serve these key segments, especially compared to the easy, safe and large lending appetite of our government. Nearly three-quarters of all the money deposited across banks is given to the government in the form of loans or investments by banks. This voracious appetite and easy profit from the government has crowded out private sector needs.

The good news is that the recent influx of venture capital into start-ups has led to the emergence of many new innovative financial technology (fintech) companies to solve these problems. Signals such as salary information, sales receipts and supply purchase data are being digitised and leveraged to establish creditworthiness with great success. Pakistani innovators benefit from the learnings from other emerging markets that previously cracked these problems with great success, including China, Indonesia, Africa and others. It should be no surprise that digital lending has started to make great progress in Pakistan.

For digital lending to truly take off in Pakistan, three key pieces of the ecosystem need to come together in a symbiotic manner: banks or money suppliers, fintechs and digital data-generating platforms. Banks are flush with cheap deposits from zero mark-up current accounts and therefore have the capital to lend. Fintechs, whose licences are governed under progressive lighter weight regulations, efficiently package small business and consume uncollateralised loans by acquiring and scoring them digitally. And finally, the platforms that collect the digital footprints of small businesses and consumers through transactional workflows, provide reliable signals for lending. They also embed financial services from fintechs into their platforms. The good news is that there are already several examples of all three stakeholders collaborating to lend in Pakistan with stellar results.

Pakistan’s five million micro and small businesses are stuck in a stagnant cash flow-starved hand-to-mouth status quo. Yet, they constitute 40% of our GDP and employ almost 80% of our non-agricultural workforce. Small and medium-sized enterprises (SME) lending data from fintechs shows that access to capital increases SME income by an average of 30%. Digital lending at scale to small businesses will have a tremendous impact on our economy, employment and standard of living. Similarly, less than 0.35% of people have received housing loans and consequently, home ownership remains dismally low. It is clearly in the country’s interest for responsible digital lending to take off.

Not only is increased digital lending the need of the hour, but it is also a very attractive business proposition. We have seen the entry of several well-funded foreign lending apps that have sprayed thousands of loans using sparse scoring data. As a result, their first cycle loan losses are exceptionally high, requiring expensive pricing to cover defaults. Many of these apps are unlicenced and engage in predatory practices. Customers are misled through claims of reasonably priced loans while hidden fees result in expensive triple-digit markup rates. Furthermore, the address books of customers are often harvested and their contacts are harassed if loans are not repaid on time. Most people who take loans from these apps are first-time borrowers with little financial literacy and can easily become over-indebted. Access to affordable credit with dignity is an important measure of a society’s evolution.

Clearly, increased regulatory oversight is urgently needed to keep pace with the innovations in digital lending that we are seeing in the field. Informal players like these loan apps and your local electronics store do not share loan repayment behaviour with credit bureaus. This results in financial institutions approving loans that are unlikely to be repaid, ruining future credit access to a vulnerable segment that can benefit most from them. This must be carefully monitored and regulators must encourage lenders to utilise high-quality data to minimise defaults and keep loans affordable for greater impact. For example, low default rates of working capital loans that leverage actual business transactional data through embedded digital workflows allow small businesses to negotiate better rates. These digital loans scored using rich data give power back to small business owners who can in turn profitably grow their businesses and hire more workers.

In addition, as data becomes more sought, stored, and potentially shared, our consumer data protection laws will be tested and likely need to be updated. We will inevitably hear about large-scale data breaches and their aftereffects. While data leaks must be prevented and privacy protected, platforms across the ecosystem must also integrate and share data responsibly. This must happen with consumer consent. Combined data sets will produce richer signals to unlock more opportunities.Seldom in human history have we had such powerful tools to uplift our population in such a short period. One hundred and ten million digitally connected and transacting Pakistanis will produce rich footprints to enable lending for themselves and their businesses. When regulated and executed responsibly, digital lending has the potential to uplift millions of Pakistanis out of poverty and significantly raise Pakistan’s GDP. Amid the doom and gloom, exciting times lie ahead.

Monis Rahman is co-Founder and CEO, Dukan, and co-founded Finja and Rozee. LinkedIn: linkedin.com/in/monis